Mauled economy seeks a way out
The pain felt by emerging economies like South Africa is intensifying as a rates hike by the United States before the end of the year becomes increasingly likely.
Amid a global sea change, the South African Reserve Bank’s monetary policy committee (MPC) will have to consider several factors, the weak rand in particular, when it decides on interest rates next week.
Although it is generally agreed that damage control will be at the top of the mind of the South African Reserve Bank’s governor, Lesetja Kganyago, the smart money is split between whether he will hike rates or hold them.
Clearer communication from the US Federal Reserve about its intention to raise rates, paired with stronger than anticipated jobs data in the US, saw the dollar strengthen on Friday, November 6, as expectations of a rates hike in December were supported.
It was enough to send the rand-dollar exchange rate past an all-time low of 14, and to keep it there after it reached a new record low of 14.38 on Tuesday, November 10.
South Africa’s situation is compounded by several other misfortunes. Power load-shedding might be held at bay until next year, but behind it is an alarming reduction in energy demand, which is likely to reveal a severe effect on economic growth. Third-quarter gross domestic product (GDP) numbers due out later in the month will show whether South Africa is in recession – and whether it has any hope of achieving the little 1.7% economic growth forecast for the year.
The nationwide drought, with the risk of crop failures, bodes ill for food price inflation, and water shortages and rationing are affecting several of South Africa’s metros. Global resource surpluses are also keeping commodity prices low.
The bottom end of the resources super-cycle means the price of oil is remaining close to $43 a barrel and this is keeping inflation in check for now. The low oil price is helping to offset the detrimental effects of the weak currency, which is devastating for most parts of the economy – except the JSE, which is home to several listings that earn in dollars but incur costs in rands. This is despite major corporates such as MTN facing colossal fines in Nigeria and the platinum mining company Lonmin taking drastic steps this week to keep itself from going under.
Analysts are divided over how the Reserve Bank will steer South Africa through these rough waters.
The monetary policy committee meeting, scheduled for next week, will be the last for the year, and the Reserve Bank will have to wait until its first meeting of 2016 to factor in whatever decision the Fed’s open market committee (FOMC) makes on rates in December.
Peter Attard Montalto, an emerging markets economist at Nomura, in a recent note said the Reserve Bank would need to ensure it is not too far behind, or ahead, of the curve.
“We think, while the hawks will be happy to hike ahead of an FOMC move in December and doves happy to wait, in the middle there will be some stress about being ahead of the curve in a low-growth environment, moving things forward too quickly.”
But the room to pause was extremely limited, Attard Montalto said. Nomura’s expectations about South Africa hiking rates were firmly linked to a “lift-off” of a rates hike in the US, “and particularly the market reaction to that event on the horizon will be a key driver of the cycle for the MPC”.
Attard Montalto said there would be a much greater “credibility loss” if the Reserve Bank paused now and the FOMC moved in December, than if the Reserve Bank hiked rates and the FOMC did not.
“Thinking of it another way, when markets looked at who hiked from start November to end December, they will see a mass of central banks with meetings after the FOMC on December 16 ready to hike if the FOMC does lift off, and will not want to be left out as a vulne-rable country.”
In recent weeks, several central banks, including Australia, Russia, Romania and South Korea, held their interest rates at current levels.
Kganyago showed he does not shy away from taking bold steps when he hiked rates earlier this year, and held firm despite market commentators suggesting he had made the wrong move.
Nomura assigned a 75% probability to a rates hike of 25 basis points next week.
But an Investec economist, Annabel Bishop, expects the Reserve Bank to hold rates at current levels, as growth remains weak and inflation forecasts are holding up.
“South Africa does not have to hike interest rates as, or before, the US does, and domestic factors need to have equal if not greater consideration, particularly the very weak state of South Africa’ s GDP growth,” Bishop said in a note.
“South Africa has been at risk of a recession this year as the global economic slowdown and commodity slump, together with domestic constraints, translated into an industrial recession, and so slowing real disposable income growth and weakening consumer demand.”
According to Bishop, the Reserve Bank, faced with a “narrow probability that South Africa will avoid recession this year”, should, on balance, keep interest rates unchanged.
If the GDP figures for the third quarter are negative, it will mean the country is in recession. The second quarter registered a retraction in economic growth.
Eskom’s announcement that there will be no load-shedding until April next year has prompted concerns that slowing electricity demand is directly linked to slowing economic activity.
But manufacturing output data for September released this week provides some hope that a recession has been averted – a 0.9% increase in output was recorded, compared with the same period last year.
“One swallow doesn’t make a summer,” said Azar Jammine, the director and chief economist of Econometrix, “but the manufacturing data is so positive it will be quite a tall order for us to have recorded negative growth in third quarter.”
With the drought getting worse, it could cause a recession next year, he said. But technically, agricultural GDP had contracted so severely in the first and second quarters of the year it would have to be even worse in the third quarter to drag growth down.
Data on Thursday indicated mining production contracted in the third quarter, meaning South Africa’s economy remains at risk of recession and an interest rate hike next week would be “ill-advised”, Bishop said.
Undoubtedly, the biggest factor now is the weak rand, which lost 6% of its value on a real trade-weighted basis since the last MPC meeting on September 23.
“Many emerging markets have followed suit, but it appears the rand has fallen more than any other emerging market currency, other than Turkey,” said Jammine.
“You could say it’s about things like the student protests. But there is an alternative, more technical reason. The rand is a very liquid market, and foreign investors use it as a proxy to take positions.”
Jammine said the weak currency has had a positive effect on the balance of trade deficit, bringing about an adjustment, but he said concerns would remain over whether the effect of the weak currency on inflation down the line could be significant, despite it not having had much of a pass-through effect on inflation as yet.
Domestically, the inflationary effect the “grotesque intensification” of drought could have on food prices would also be of concern, he said.
Chris Hart, of Standard Bank Wealth and Investment, said the weakening of the rand was likely to continue, especially with the increased need to import food as a result of the drought.
Without a rate hike at home, but lift-off in the US, the rand weakness could become disorderly, Hart said, adding that, at the moment, at least it was following a steady trend. “I don’t see us not hiking rates … unless the rand falls back below the 14 or 13 level,” he added.
Given the persistently weak oil price, Bishop also argued the Reserve Bank’s oil price forecast might be too high, and subsequently its inflation forecast would also be.
“We feel the South African Reserve Bank will be more cognisant of the fragility of South Africa’s economic growth, and the impact interest rate hikes do have on employment and domestic demand,” Bishop said. “Failure to show such sensitivity will likely see the rand weaken further, and will certainty suppress economic growth next year.”
Referring to the effect of the weak rand on the JSE, Wayne McCurrie of Momentum Asset Management said: “The weak rand is having a positive effect on the share market. Commodities are being pounded, but they would be pounded even more were it not for the weak rand.”
It may be a silver lining of sorts for some resource companies, but currency weakness was certainly not enough to help Lonmin, which this week announced a rights offer that will see it issue additional shares at a 94% discount.
“The underlying problem is just a low platinum price; they [platinum mines] are all losing money,” said McCurrie. “Everyone is in the same boat; Lonmin just has the biggest hole.”
The size of the discount was indicative of Lonmin’s desperation, he said. “If you are in trouble, like Super Group, or Sappi, or even Lonmin a couple of years ago, you do a 25% or 30% discount. A 94% discount is unheard heard of. It almost forces you to take up your rights and means underwriters will underwrite it because you can pick up the share for nothing,” McCurrie said.
Of the major shareholders, only the Public Investment Corporation, which manages the Government Employees Pension Fund, has indicated it will follow its rights (and underwrite an undisclosed part of the offer). With a 7% share, René Hochreiter, a mining analyst at NOAH Capital Markets, estimated the PIC will have to put in R403-million to follow its rights. A 7% of the Lonmin market cap on Thursday was worth more than R220-million.